Republic ofthe Philippines Bicol Universit College of Business, Economics Management Daraga, Aloay{ THE STANDARD TRADE MODEL Chapter V International Trade and Agreements BA Core Course 6Republic ofthe Philippines Bicol University College of Business, Economics Management Daraga, Albay) sets 2 A OVERVIEW ‘This chapter stresses the insights from international trade theory that are not strongly dependent on the details of the economy's supply side. We develop a standard model of a trading world economy of which the models of Topics 2,3 and 4 can be regarded as special cases and use this model to ask how a variety of changes in underlying parameters affect the world economy. {] 8. OBJECTIVES ° 1, Define terminologies and understand the concept of the Standard Trade Model, 2. Understand existing patterns of international trade, 3. Be guided with the content of the succeeding topics. C. LEARNING OBJECTIVES 1. Recognize how changes in the terms of trade and economic growth affect the welfare of nations engaged in international trade, 2. Understand the effects of tariffs and subsidies on trade pattems and the welfare of trading nations and on the distribution of income within countries, 3. Relate international borrowing and lending to the standard trade model, where goods are exchanged over time, D. INSTRUCTIONS 1. Kindly read and comprehend this topic on The Standard Trade Model. Bear with the length of the modules. You need to read in order to learn, However, if some of the concepts confuse you, I will explain them to you on our next virtual meeting. Do your best to ‘comprehend. As I've said, dreams are unreachable for motivation too low, Kaya mo ‘yan, tiwala lang! I'm here to guide you. 2, Watch the video suggestions or read the suggested materials, i there's any.Republic ofthe Philippines Bicol University College of Business, Economics Management Daraga, Albay| 3. Prepare the Assignment, if there’s any, The deadline is a week after you receive this module. Send the output with the filename: ITA_Topic I Output_Course-Year & Block Surname, First Name, Middle Initial (ex, 1TA_Topic I Output_BS Economics 3B_Garcia, Riza L.) 4, Should you have any questions or concems, please message me via: a, Email at riza.garcia@bicol-u.edu.ph Messenger Group Chat 5. Enjoy your own pace, ‘cause learning is never a race. In these hard and trying times, 1 understand that you are walking on a rough patch, Do not forget to pause, breathe, and carry on! You got this!Republic of the Philippines Bicol University M College of Business, Economies Management Daraga, Allbay| suntan E. DISCUSSION ‘THE STANDARD TRADE MODEL Previous trade theories have emphasized specific sources of comparative advantage which ‘give rise to international trade: ferences in labor productivity (Ricardian model) ifferences in resources (Specific Factors Model and Heckscher-Ohlin model) + The Standard ‘Trade Model is a general model of trade that admits these models as special cases. : A STANDARD MODEL OF A TRADING ECONOMY ‘The Standard Trade Model is built on four key relationships: 1. The relationship between the production possibility frontier and the relative supply curves 2. The relationship between relative prices and relative demand; 3. The determination of world equilibrium by world relative supply and world relative demand; and 4, The effect of the terms of trade —the price of a country’s exports divided by the price of its imports ~on a nation’s welfare, PRODUCTION POSSIBILITIES AND RELATIVE SUPPLY Assumptions of the model: Each country progkuces two goods, food (F) and cloth (C) Each country’s production possibility frontier is a smooth curve (TT) ‘The point on its production pos price of cloth relative to food, PC /PF. ity frontier at which an economy produces depends on the ‘An economy whose production possibility frontier is TT will produce at Q, which is on the highest possible isovalue line, Asovatue tines ~ Lines along which the market value of output is constantRepublic of the Philippines Bicol University X College of Business, Economics Management Daraga, Albay) Relative prices and relative supply: ~ An increase in the price of cloth relative to food PC IPF makes the isovalue line steeper. - Supply of cloth relative to food QC /QF rises. - Relative supply of cloth to food inereases with the relative price of eloth to food. Ieovaue tines ‘lot production, Qe Fig 1 Relive piss damning th enon copa / RELATIVE PRICES AND DEMAND ‘The value of an economy's consumption equals the value of its production: PCQC + PFOF = PCDC + PFDF=V The economy's choice of a point on the isovalue line depends on the tastes ofits consumers, ‘which can be represented graphically by a series of indifference curves. INDIFFERENCE CURVES are downward sloping — if you have less cloth, then you must have more food to be equally satisfied. le farther from the origin make consumers more satisfied — they prefer having more of both goods. ‘become flatter when they move to the right — with more cloth and less food, an extra yard of cloth ‘becomes less valuable in terms of how many calories of food you are willing to give up for it. Food production, Q, WELFARE EFFECT OF CHANGES IN THE TERMS OF TRADE ‘Terms of Trade - The price of the good a country initially exports, divided by the price of the good it initially imports, - A rise in the terms of trade increases a i country’s welfare, while a decline in the terms of ‘lot prouetion, . Fe 2 Penn Cocunpin stent Sunita ae Fences its welfareRepublic ofthe Philippines Bicol University College of Business, Economics Management Daraga, Albay af ECONOMIC GROWTH: A SHIFT OF THE RS CURVE. Is economic growth in other countries good or bad for our nation? It may be good for our nation because it means larger markets for our exports. It may ‘mean increased competition for our exporters. 1s growth in a country more or less valuable when that nation is part of a closely integrated world economy? It should be more valuable when a country can sell some of its increased production to the world ‘market. Itis less valuable when the benefits of growth are passed on to foreigners rather than retained at home, RELATIVE SUPPLY AND THE TERMS OF TRADE, Export-biased growth Disproportionately expands a country’s production possibilities i the direction of the good it exports. Worsens a growing country’s terms of trade, to the benefit of the rest of the world. Import-biased growth Disproportionately expands a country’s production possibilities in the direction of the good itimports. Improves a growing country's terms of trade at the rest of the word’s expense. Oo INTERNATIONAL EFFECTS OF GROWTH Export-biased growth In the rest of the world improves our terms of trade, while import- biased growth abroad worsens our terms of trade. Export-biased growth in our country worsens our terms of trade, reducing the ct benefits of growth, while import-biased growth leads to an improvement of our terms of trade.Republic of the Philippines University A College of Business, Economics Management Daraga, Albay te EFFECTS OF INTERNATIONAL TRANSFERS International transfers of income, such as war reparations and foreign aid, may affect a country’s terms of trade by shifting the world relative demand curve. Relat because of: + Changes in tastes fe world demand for goods may shift + Changes in technology *+ International transfers of income ‘TARIFFS AND EXPORT SUBSIDIES Implications of Terms of Trade Effects: Who Gains and Who Loses? + The International Distribution of Income If Home (a large country) imposes a tariff, its welfare increases as long as the tariff is not too large, while Foreign’s welfare decreases. If Home offers an export subsidy, its welfare deteriorates, while Foreign’s welfare increases. + The Distribution of Income Within Countries ‘A tariff (subsidy) has the direct effect of raising the internal relative price of the imported (exported) good. Tariffs and export subsidies might have perverse effects on internal prices (Metzler paradox). @ F, SUGGESTED READINGS/VIDEO MATERIALS Please check the google classroom for video materials or further readings, if there's any, S G. REFERENCES Mankiw, W (2012) Prinepts of Eeancmi. Pasig Clty: Cengage Learning Asa le Li. Pilppine Branch, Paul R krugman, M0. 2003). Inernatonal Economies Theory and Poly, HehElton. 75 ington St, Sule 300, Goston, MA (02116: Pearson Education, ne